Given the current state of the economy, it should come as no surprise that business related bankruptcy filings increased 41.6 percent and non-business bankruptcies increased 28.4 percent between June 30, 2007, and June 30, 2008, with more than one million Americans filing for bankruptcy during calendar year 2007, according to the Administrative Office of the U.S. Courts.
One of the most significant tax provisions contained in the recently enacted American Recovery and Reinvestment Act of 2009 (“ARRA”) might prove helpful to certain taxpayers looking to restructure their balance sheets.
Debt-for-debt exchanges are not new, but are worth revisiting given the current economic climate. Furthermore, the recently enacted "Stimulus Act"1 provides some temporary relief to debtors from potentially harsh tax consequences of restructuring. The following discussion is relevant to issuers (also referred to as debtors) or holders (also referred to as creditors) of debt who are "US persons" (as defined in the US Internal Revenue Code).2
In order to illustrate some of the key US federal income tax consequences of a debt-for-debt exchange, consider the following example:
It is not surprising that within an economic outlook which seems permanently set to "gloomy" many companies are having to think about reorganising their operations or restructuring their holding structures This article highlights some of the tax and other considerations which must be borne in mind when considering such reorganisations or restructurings with reference to some recent (and less recent) cases and changes in the law and points which have come to the fore in the current climate.
Recapitalisations
Under Section 1031 of the Internal Revenue Code, a taxpayer does not recognize gain or loss on the exchange of like-kind property. Before 1984, the Code did not specifically address so-called deferred exchanges - exchanges in which the taxpayer relinquished property and some time later received the replacement property - although at least one leading case did. The 1984 rules require that the taxpayer identify the replacement property within 45 days after the disposition and close on the replacement property and close within 180 days after the disposition.
With an increasing emphasis on identifying value in the marketplace, entrepreneurs have focused their efforts on acquiring debt instruments, senior secured and mezzanine, in particular. Two primary strategies are being employed with respect to the debt: (1) acquire the debt for the purposes of restructuring the terms with the borrower(s) or (2) acquire the debt for the purpose of exercising the creditor’s remedies (i.e., foreclosing on the equity).
As a general rule, a debtor realizes taxable income upon the partial or total cancellation of its debt. Special rules may apply, however, when the debtor is a “pass-through” entity—e.g., a partnership, a limited liability company (LLC) that is treated as a partnership for United States federal income tax purposes or a subchapter S corporation. Cancellation of debt (COD) income realized by a pass-through entity generally passes through to the entity’s owners, with each owner being required to report its allocable share of such income on its own income tax return.
A Virginia bankruptcy court has issued a decision that should be a major eye-opener for any entity that engages in tax-free exchanges under section 1031 of the Internal Revenue Code.
In the economic downturn, many corporations have filed or will file for bankruptcy.
On June 17, 2009, the Seventh Circuit examined the tax practitioner privilege in Valero Energy Corporation v. U.S., 103 AFTR 2d 2009-2683. Valero, a large oil refiner, expanded its operations in 2001 by acquiring Ultra Diamond Shamrock Corporation (“UDS”). Prior to the acquisition, Ernst & Young developed a restructuring and refinancing plan for UDS’s Canadian subsidiaries. Valero asked its tax advisors, Arthur Anderson, to review the plan and provide additional tax advice.